Book Eleven - A Pause for Perspective

Book Eleven. A PAUSE FOR PERSPECTIVE MONEY, it becomes apparent as we survey its modern development, is nothing more than debt—a vast structure of lead thinly veneered with gold. What men accept for their daily toil and for the product of the field or work bench is not a tangible substance endowed with intrinsic value but an evidence of debt. In this country, in England, and to a smaller degree in other countries, this evidence of debt consists of deposit credit, the obligation of a bank to pay out a certain sum of money on demand. Elsewhere, in less developed countries, the paper note of the government serves the same purpose. Yet so accustomed have men become to this form of money that its perils and consequences must be argued before a hostile court of economic opinion. Such a task we now undertake. /. The Cost of Bank Money LET US note first the dilemma of those who oppose fiat paper issued by the state, but agree to the use of checkbook money and private bankers' notes. This dilemma is that of the interest burden such a system imposes, and the necessity of encouraging the incubus of debt.

"Under democracy," says Professor Frederick Soddy, who analyzed the system in Great Britain, "the prerogative of the issue of money has been usurped by private financial companies, and the state money is reduced to a trivial proportion of the whole. Clearly the profits of the issue of money should belong to the community. A counterfeiter issuing money is punished, if convicted, for treason rather than theft. But the banks, by the check system, have invented a means of issuing money without coining it or even issuing a bank note.... In this way, well over £2,000,000,000 worth of wealth has been taken from the public 237 238 MONEY AND MAN and is owed to the banks by those who have borrowed it, and by the banks to their clients * Bank checks, to explain Professor Soddy's thesis in its American application, which serve as the medium for some 90 per cent of payments, are drafts upon bank deposits; these bank deposits, as we have noted, arise from loans made by banks to customers, for the use of which the banks receive interest payments. Though individual borrowers may be perfectly willing to pay interest for the use of their loans, the total amount so paid becomes a tax upon commerce for the use of a medium of payment.

This becomes more apparent when we consider that the price structure of the country is built up in relation to the vast amount of purchasing power represented by bank deposits, rather than in relation to the smaller amount of actual money outstanding, and that the stability of the price structure is conditioned upon a corresponding stability in the amount of bank credit outstanding. Most proposals for "reflation," for instance, imply a reexpansion of bank credit: this means that borrowers must be found to absorb the bank credit it is proposed to issue, and that interest must be paid to the banking system for the use of the new check-money with which the country is to be supplied. In other words, a system of bank deposit money must be constantly supported by a flow of interest payments to the banking system for its services in providing the medium of payment. As interest payments themselves are made in this same deposit currency, the process involves a constant increase of credit money in order to supply the necessary funds for these interest payments. This is obvious if we realize that to support the nearly fortythree billion dollars of commercial deposits outstanding in 1930, at an interest rate of 3 per cent, required over a billion and a quarter dollars annually. To discharge such a sum in actual money (gold) would have required some three times as * From Money versus Man (London, 1931). Professor Soddy was not a professional economist, but a distinguished English chemist, and his observations, penetrating as they are, put him on the other horn of the dilemma—the acceptance of fiat paper money.

A PAUSE FOR PERSPECTIVE 239 much gold as was produced by the world in that year. A system of deposit money supported by debt and its handmaiden, interest, necessarily feeds upon itself, and must forever be increasing. Let it cease to grow, and it must collapse. A frequently heard argument for managed money is the necessity of maintaining a stable price level. Unfortunately, the operation of this theory has never been dispassionately examined. Instead, the catastrophic effects of sudden rises or falls in the price level are displayed to the electorate. Men are reminded of the fearful effects of falling prices—factories closed, millions thrust into idleness, homes and farms foreclosed, businesses thrust into bankruptcy—all because of a drop in the market. Since rising prices generally proceed more gradually than falling prices, and carry with them a train of speculative profits, the dangers of inflation are less frequently preached and more dubiously received. Yet a vast amount of fruitless effort, just as catastrophic in effect, may be expended under the influence of rising prices. Equally destructive are differences within the price structure—the scissorlike movements that price indexes tend to conceal. Such differences were particularly wide in the decade 1920-30, but were either overlooked or ignored by analysts.

These differences became acute in the cases of prices for agricultural products and manufactured products; of capital goods (securities and real estate) and consumption goods; of wage rates and costs of food, clothing, and shelter. They were characteristic also of the 1974-75 recession, in which prices of real estate soared while security prices collapsed. The unnoticed paradox is that these divergencies have been accentuated and aggravated by the system of bank money, that is, checkbook money. When banks extend credit they create purchasing power, and when this movement is on a broad front, a decisive effect upon the price level follows. To explain this process let us revert again to the early goldsmiths. Here are two London merchants, dealers in rugs, who keep their cash on deposit with a goldsmith. A shipmaster arrives 240 MONEY AND MAN from the Orient with a cargo of rugs which he wishes to sell, and with the proceeds to buy a cargo of cloth. As the two merchants know how much gold they have on deposit in the goldsmith's strong box, they know how much they can bid for the rugs, and the resulting price will be within range of their particular ideas of value.

Now a shrewd and adventurous young merchant conceives that he can successfully buy and sell the rugs if he can obtain the cash for the original purchase. He approaches the goldsmith and urges from him a loan, not of gold, but of a written receipt for the gold. He convinces the goldsmith that when the shipmaster has sold the rugs, he will use the receipt in turn to purchase his cargo of cloth, and that consequently the gold will not be called for. The young merchant, on his part, will repay the loan with interest when he has sold the rugs. Now, instead of two competitors for the rugs there are three. The total purchasing power of the community has been increased. With three merchants bidding for the rugs, the price rises. A new factor in price making has been created which clearly tends to advance prices.1 If the buyer of the rugs is to dispose of them in the market and so repay the loan to the goldsmith, new buyers able to pay the enhanced price must in turn be found. To aid these secondary purchases, the use of the goldsmith's credit may again be called into play. He finances these purchasers, and so the circle of debt widens, and with each new increment of debt, a new hoist is given to the general level of prices. Everyone is happy, but whether everyone is better off is questionable.

The effect of the system is to place the price structure upon a basis that is purely psychic, rather than upon the actual relationships existing among commodities in the market, and between goods and needs. Primarily, the level is sustained by confidence in the goldsmith's receipt, and beyond that, upon the future productive power of the community. For the increments of purchasing power are derived from debt, and the willingness A PAUSE FOR PERSPECTIVE 241 to go into debt, or to extend credit, is based upon confidence in the future. The future is a world into which we can never enter but which we can populate with all the creatures of the imagination. Ages of it stretch ahead, a magnificent vista lambent with wealth and power. By the mystic formula of credit, this wealth is tapped and made to flow in a copious stream into the arid valley of the present. By mortgaging the future, pledging the productive power of unopened mines, uncut forests, unbuilt factories and unborn generations, a tremendous demand may be created for wares already produced in the markets.

At the end of 1929, the total net debt of the country—public, corporate, and private—stood at $190 billion or double the total national wealth of thirty years earlier.2 By any definition, this debt represented the exchange of tangible, created wealth for uncreated wealth existing only in the future. That future embraced in one generation, both the severest economic depression and the most disastrous war in history. Yet such was the extent to which that uncertain future was mortgaged that over $1.2 billion of debt existed in 1929 with a maturity three generations distant—that is, after A.D. 2000—burdening each generation with an interest cost equivalent to the corpus of the debt. The editors of Fortune reported that Florida land sold at a price that would have required for its amortization the income of a building 200 stories high with all offices rented in perpetuity. (And despite this experience, to this day development land continues to command prices that can only be validated by a continuation of inflation.) During the years prior to 1929, the price structure seemed firmly founded, so stable indeed that leading economists doubted the existence of a credit inflation. The delusive character of the structure was revealed when the psychic foundations began to weaken. The credit resources of the country were being strained to the limit—not that there was insufficient gold at the time to support the banking operations under the legal reserve requirements, but that the imagination was becoming exhausted. It was, for instance, being stretched to the limits of human capacity to 242 MONEY AND MAN envision a future productive power in South American countries capable of sustaining interest and amortization service on the millions of dollars of bonds that were being offered in this market. It was being hard put to sustain its faith in a banking system in which over five thousand institutions had failed. It was finding hard the task of populating innumerable skyscrapers with swarms of busy workers. And when, finally, it was asked to believe that poverty had been abolished and want annihilated, it succumbed in exhaustion.

Not only does the system of bank money tend to enhance prices and to sustain them at an artificial level, but it aggravates and intensifies what otherwise might be a natural adjustment downward. Bank credit is not only dependent upon future productive power but upon the future prices at which this production will be sold. If the prices of commodities upon which credit is extended tend to weaken, the basis of the credit is destroyed, and immediately the whole house is pulled down. Let us assume that another shipmaster, learning of the high prices received for rugs in England, leaves his normal route and hastens thither with a fresh cargo of rugs. The market is now glutted. The goldsmith, seeing his security vanishing, demands a repayment of the loan from the young merchant. To pay the loan the young merchant must hurriedly sell everything he has. These forced sales break the market, other debtors are involved, other loans are called, and as the circle widens the ruin increases.

The contraction of bank credit produces a strange paradox. In four years after the stock market debacle of 1929, for instance, commercial bank deposits dropped by about $14,000,000,000, or a decline of 30 per cent from the peak. The decline in bank deposits meant, essentially, that borrowers at banks were, willingly or unwillingly, paying off loans. It meant that the country was, to that degree, getting out of debt. That a process which should be wholesome and salutary should have the opposite effect, should provoke such disaster as to lead the country to the verge of revolution, can be accounted for only by the deceptiveness of the money system.

A PAUSE FOR PERSPECTIVE 243 The obverse of this paradox is the situation produced by the frantic efforts to expand the money system by "pumping credit" into the banking structure by way of the Federal Reserve System —central bank credit policy, it is called—in the hope that it will be absorbed by the commercial community. To alleviate the burdens of a people already so bowed with a burden of personal, corporate and governmental debt that they are almost prostrate, by a process of inducing them to assume more debt, is like relieving anaemia by the medieval process of bloodletting. It is of course, a recourse that has a certain method in its madness. Our perfectly enormous debt structure was never intended to be paid off. It is liquidated only by means of fresh debt. If in prosperous times people began paying off their debts— which never happens, of course—the results upon the money and economic system would be just as disastrous. Once we have allowed the pillars of debt to rest upon our shoulders we are in the position of Atlas—let us budge an inch and the skies tremble.

Still another harmful effect of the system of bank money upon the price structure is the inequalities which it creates within the structure itself. Bankers, no more than society women, are not immune to fashion trends. Because of the compactness of the money market and the influence of Wall Street, certain types of investment risks acquire favor and status. Thus, after World War I, the shortage of commodities attracted banking interest. Bankers thought it good business to lend against inventories of cotton, copper, sugar, silk and the like. When a buyer's strike— which meant no more and no less than that consumers could not pay the prices demanded (for consumer's credit was still in swaddling clothes)—finally broke the market, havoc was widespread. The banking system, its fingers burned by this experience, but with credit power untouched, expanding under the credit policies of the Federal Reserve System and ready to flow into whatever new channels might be opened, now turned to securities. Securities were marketable, theoretically, and apparently satisfied the requirement of "liquidity." And so the banking sys244 MONEY AND MAN tern, as we have seen, went heavily into security purchases and the financing of security flotations. And while the banking house reviews were complacently taking note of the stability of the commodity price index and the low state of inventories—"hand to mouth buying" had become the new rule of industry—a tremendous inflation was piling up in the field of capital goods, securities and real estate.

During the 1920-30 decade, for instance, the country experienced a building boom, but only in specialized types of construction—types which were conveniently financed, such as office buildings and expensive multi-family dwellings. After the storm had passed, and the skies cleared, observers looked about to discover a forest of office buildings rising gaunt and empty in the evening sky, while at the same time the American people were living under perfectly wretched conditions of housing. In New York City, for instance, where at least four skyscrapers were built in these years with the only object, apparently, of surpassing the record for the world's tallest building, from a quarter to a third of the population, say 1,800,000 persons, still occupied houses that had been outlawed thirty-three years earlier by the Tenement House Act of 1901.3 The availability of quick and easy credit against collateral has provided leverage for violent fluctuations in the stock market, particularly in stocks that enjoy favor among bankers and investment managers. We cannot attribute such fluctuations to the bankers, but there can be no doubt that the leverage of credit increases the range. "Styles" in stocks—glamour stocks— are a well known phenomenon of the market. Thus, in 1916 steels were the darling of investors; in 1927, mail order companies; in 1940, cement companies; in 1960, life insurance held the stage. The recent craze has been for companies growing by acquisitions known as the conglomerates, from the disparate variety of enterprises brought under single control.

Thus, those who demand credit expansion fail to realize that purchasing power created by the banking system is unevenly distributed—going mainly to those enjoying banking connections and in position to take advantage of distressed markets while the rest of the community must wait. Efforts by the moneA PAUSE FOR PERSPECTIVE 245 tary authorities, or by legislation, are at best only mildly effective. Credit is rightly "liquid" and finds ways of flowing through legislative fences. The result is to widen the gap between rich and poor. The increasing control over the banking system by the Federal Reserve and the increasing intervention of government in the economy, both through control of private banking and by the proliferation of government lending agencies, have not changed the character of the phenomenon. Rather, they have sharpened the problem. But for our purposes, instead of speaking of the banking system we must speak of the money managers.

Thus, we say that their power to direct the flow of credit and purchasing capacity has become even more vicious both in times of prosperity and in times of depression. This leads directly into a field of inquiry which comprehends not only our economic system but the fundamental social and political relationships of men upon which the solidarity of the existing order depends. //. Credit Imperator GOING into debt through "buy now, pay later" has become such an accepted pattern of modern life that anyone who rises to question the institution of credit is apt to be regarded as a little queer. Credit buying not only is stimulated by merchants and manufacturers and by all those who have goods to sell, but is practically dictated by our income tax administration which finds a check better evidence of a deductible expense item than the taxpayer's ledger. Despite the jokes about the uses of credit, it has become a matter of prestige and status to pay for everything on time. Celebrities, like movie stars, with income in the millions, boast that they never carry more than $50 in cash.

Wallets that formerly held coins, and later paper money, are now stuffed with credit cards. With proper credit identification, one may travel around the world with hardly a penny in cash.

246 MONEY AND MAN This phenomenon creates new problems for the monetary economist in defining money, or the quantity of money in being. Nevertheless, though we be charged with fighting windmills, we propose to examine some of the less obvious consequences of the use of credit. An immediate consequence of the credit inflation of the nineteen twenties was the concentration of wealth into the hands of a few. Doubtless there were many other factors that fostered differences in the ownership of wealth—the natural disposition of men, for one: some being thriftless, others thrifty; some lazy, others industrious; some generous, others acquisitive; some ascetic or poetical, others practical and materialistic; some healthy or vigorous, others sickly. Laws like those of copyright and patent have tended to enhance the rewards of endeavor in certain fields, though not in others—ideas themselves not being subject to patent or copyright, but once released, belong to the world like the raven which Noah sent forth. Differences in the resources of the earth, and private title to these resources, also make for differences of wealth. Yet among all these various influences none has been more significant in modern times than access to credit as a means to affluence.

The concentration of wealth by use of banking power became a phenomenon of the nineteen twenties that attracted attention of scholars and statesmen.1 That its importance declined in subsequent decades is accounted for by the shift in the direction of credit from private users to public: the banking mechanism, operated mainly through the Federal Reserve System and the government bond market, became a chief agency after 1930 in transferring economic power and monopoly from private hands to the state. This development we shall survey further on. Employing its power to create purchasing power—a power limited only by a superficial relationship to the amount of gold laid in bars and coin in the vaults of the Federal Reserve Banks —the banking system lent its resources to finance industrial consolidations and corporate structures that were stupendous for the times and for even a later generation inured to speaking of billions instead of millions. Many of these financial empires, particularly the utility holding companies, had no justification A PAUSE FOR PERSPECTIVE 247 other than financial—an increase in monetary profits. Frequently, these owed their existence to credit granted in the first instance by a commercial bank to a promoter, for the purchase of securities, and subsequently, by the commercial banks to the investment banks for the flotation of securities issued by the promoter for the expansion of his enterprise.

The researches of Berle and Means on the concentration of wealth became politically explosive. They disclosed that in 1930, of the wealth represented by the 303,000 corporations filing income tax returns, over half was in the hands of 200 large corporations; among them were 45 railroads, 58 public utilities, and 97 industrial corporations.2 These huge corporations did not, with few exceptions like the Ford Motor Company, grow out of earnings. Thus, a huge amusement enterprise embracing motion picture producing companies and a nation-wide chain of motion picture theaters, accumulated by William Fox, became possible largely through commercial bank credit which Fox was able to command—and when he no longer held the confidence of the bankers his enterprise toppled and he disappeared into obscurity. In 1929 the United Corporation was formed under the influence and assistance of the House of Morgan; within a year it held effective control of 22.6 per cent of the electrical production of the country.3 By his ability to hoodwink a group of Wall Street bankers, a Swedish promoter by the name of Ivar Kreuger—of whom little was known beyond his name—became lender to impecunious governments throughout the world, obtaining in return valuable monopolies together with the sobriquet of "the Match King." Two real estate operators in Cleveland, the Van Swearingen brothers, with the assistance of Cleveland and Wall Street bankers, became masters of railroad properties of over $2 billion in assets.

The method by which these concentrations of wealth were brought about is of interest.4 Essentially, it depended upon two instruments of leverage—(a) a commercial bank willing to lend upon the unsecured note of a customer, and (b), a hierarchy of 248 MONEY AND MAN securities ranging from mortgage bonds secured by physical properties through unsecured bonds, simple debentures, preferred stock, non-voting common stock, common stock, and sometimes merely rights to subscribe to common stock. The operation would begin with a shortterm loan to the promoter by means of which he would acquire a certain amount of stock of a nucleus company—a company with a history of earnings and well-seasoned marketable securities. This stock would be used as collateral for further bank borrowing, and when the word got around that so-and-so was buying, the price would move up enough to provide a margin of collateral to satisfy the banker. When sufficient securities had been acquired, a holding company would be organized to which they would be transferred—frequently at a profit to the promoter—and a friendly investment house would then undertake to sell to the public the bonds or senior securities of the holding company, and thereby put it in funds for further expansion. There would be layers of holding companies, some holding each other's securities, all creating more baffling relationships than those displayed in the Almanack de Gotha, and some of them requiring years to untangle after the Public Utility Holding Company Act in 1934 decreed their demise.

The Van Swearingens acquired control of the Chesapeake & Ohio Railroad with an ownership of less than 1 per cent of the stock, and with this property in their grasp eventually dominated railway systems spanning the continent. All this power was brought under their hand by means of a holding company in which they had an initial investment of only $1,700,000, and it was brought out in the Senate hearings that the brothers had obtained this $ 1,700,000 by a bank loan.5 H. L. Doherty and Company, with the ownership of stock of a par value of one million dollars, controlled one billion dollars of assets in the Cities Service Corporation. In 1929 a group (the Byllesby interests) with an investment of one million dollars in Standard Gas and Electric Company was able to vote 41 per cent of the shares outstanding and control a billion dollars of assets. As it happened, a year or so later another Wall Street group discovered a technical flaw in the complex system of A PAUSE FOR PERSPECTIVE 249 control and was able to effect a coup and wrest control of this gigantic corporation by a similar insignificant investment.

The virus of speculation, like that of cancer in remission, remained quiescent for a generation. Then, warmed by easy credit policies, it erupted in the sixties, its fever feeding a devouring hunger for conglomerates—those corporate mastodons that grew by "trading on equities" until, in the seventies, they withered like Jonah's gourd in the burning heat of the new inflation.